Paper: Does SOFR-linked Debt Cost?
A recently published paper asks, "Does SOFR-linked Debt Cost Borrowers More Than LIBOR-Linked Debt?" The intro says, "The transition from London Interbank Offered Rate (LIBOR) to Secured Overnight Financing Rate (SOFR) affects the reference rate of floating-rate debt worth trillions of dollars. Focusing on the primary market for dollar-denominated floating rate notes (FRNs), we compare the yield spreads of FRNs linked to LIBOR and SOFR, issued by the same entity during the same month. After adjusting for the maturity-matched spread expectations from derivatives markets, we find signi cantly lower spreads for SOFR-linked FRNs. A qualitatively similar pattern emerges for syndicated loans, despite identi cation challenges. Hence, concerns that the benchmark transition resulted in higher borrowing costs are unwarranted." Written by Sven Klingler of BI Norwegian Business School and Olav Syrstad of Norges Bank, it explains, "The transition from London Interbank Offered Rate (LIBOR) to Secured Overnight Financing Rate (SOFR) is one of the most signi cant events in fi nancial markets to date -- it affects the reference rate for loans and other floating rate debt worth trillions of dollars and has sparked an ongoing debate between policymakers and market participants. While policy makers endorse SOFR as robust reference rate, one problem with SOFR is its disconnect from market-wide funding conditions as it captures the cost of funding US Treasuries overnight.... Lenders in SOFR-linked debt therefore lose the hedging benefi t of receiving higher interest payments during funding crises, which was inherent in LIBOR.... If the lenders value these hedging benefits, the transition from LIBOR to SOFR has an adverse effect on borrowing conditions for floating-rate debt. The aim of our study is to test for this adverse effect by comparing the borrowing costs associated with floating-rate debt tied to LIBOR and SOFR." The study adds, "The primary market for dollar-denominated floating rate notes (FRNs) is an ideal laboratory for our analysis -- we observe issuances linked to both LIBOR and SOFR from the same entity during the same month. In addition, the predetermined payment schedule of FRNs allows us to extract maturity-matched spread expectations from derivatives markets and adjust for the expected difference in variable rate payments. Our main fi nding contrasts with the concerns outlined above: Borrowers pay lower adjusted yield spreads for FRNs linked to SOFR and therefore benefit from a 'SOFR discount'. This discount is strongest for FRNs (i) maturing after the announced LIBOR cessation date, (ii) associated with underwriters more active in SOFR-linked debt, and (iii) facing high demand from money market mutual funds (MMFs)."
